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world-gdp-ppp-1990-2015

 

At least according to the latest revision of the World Bank’s PPP-adjusted GDP estimates.

China has long been expected to overtake the US economy (one economist dated it to as early as 2010), and there had already been a flurry in the media when the IMF claimed the same thing in December last year. The World Bank’s new figures just confirm the new reality and scaremongering about a bad night at the irrelevant casino that is the Chinese stockmarket is not going to materially change the fact. Annual growth continues at 7% per year, much the same as South Korea when it was at a similar stage of per capita development in the 1980s.

Russia’s PPP-adjusted GDP actually marginally overtook Germany’s back in 2013, and it managed to maintain this small lead into 2014 despite falling into recession. Of course with GDP expected to fall by around 3% this year, there will almost certainly be a reversal of this, but not by any radical amount – the hystrionical pronunciations of the Western media regardless – and will likely be temporary anyway import substitution really kicks in.

Financial, military, and cultural power are all ultimately functions, if lagging functions, of productive economic power. Although it would be a bad idea to go overboard with it, the spectacle of the same year (give or take) seeing both Russia overtaking the former biggest economy in Europe, and China overtaking the former biggest economy in the world, is really quite symbolic.

 
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That title sure caught you attention? Good. Now for the 1000-words-in-a-picture evidence.

gdp-human-capital-socialist-bloc-3

Human capital refers to educational attainment, as measured by the results of the PISA and TIMMS standardized tests*. As you can see, there is a very close correlation between human capital and GDP (PPP) per capita. The exceptions all confirm the rule. For now I have only done the post-socialist space, because of its sheer variety – different cultures, different rule-of-law and ease of business environments, difference resource endowments and political systems – which lets me illustrate just how irrelevant all those factors are compared to human capital. The same laws hold at the global level, and I intend to cover it in a consequent post, but that involves a lot more work so for now I’ll just settle for this.

The Near Developed nations have respectable GDP per capita (approaching the poorer members of the classical developed world, such as Portugal and Greece), and levels of human capital that are basically equivalent to those of the rich countries. They are close to converging with the developed world, so growth tends to be relatively slow by the standards of more dynamic (but much poorer) emerging markets, on the order of 3%-5%. Despite their low positions, neither Russia nor Latvia are outliers; more recent calculations by the World Bank give Russia a PPP GDP of $20,000 for 2010, wedging it in with Hungary, Poland, and Lithuania; while Latvia was very severely affected by the late recession. The Czech Republic is close to being a positive outlier: One reason may be its proximity to developed Germany, another the early start of its reforms.

The Red Train is, basically, China. Its searing growth rates aren’t because of its state capitalist system or the Confucian work ethic, but because its human capital is wildly out of line with its economic development. Its high school graduates are ready to operate complex machines and staff the most hi-tech enterprises, but the legacy of Maoist economics – which, hard as it is to believe, were even more inefficient and offered fewer incentives than under Soviet central planning – means that a significant share of the population still uses oxen-pulled plowshares for farming. So it is no wonder that, with its markets freed, the system is straining to catch up – at the pace of 10% per year – to its equilibrium place along with South Korea and Japan. Note also that according to some estimates, China’s PPP GDP is now larger than America’s, which would give a per capita level of $10,000 or so; significantly higher than the figure displayed on the graph.

The Slow Middle are countries with moderate levels of human capital, and they are significantly poorer than the Near Developed nations; for them, convergence to developed country levels is still far away. Their growth rates are modest because their economic development is only slightly, if at all, below the level natural for their degree of human capital. While Turkey and the Balkan countries don’t look that far away from the poorest Near Developed countries, it should be noted that all three are currently suffering from major disbalances that could well end up in Latvian-style crashes. To set themselves on a sustainable development path, they will have to raise their human capital levels by at least another notch. The two negative outliers are Ukraine and Armenia. Ukraine has just been horrendously mismanaged; as I argued in a prior post, it never left the period of “anarchic stasis” that characterized Russia in the 1990′s. That said, the Ukraine may not so much of an outlier; its prices are low, and salaries are comparable to Serbia’s, so its PPP GDP may well be substantially underestimated. Armenia is an even more glaring outlier, with human capital that is comparable to the weaker Near Developed members, but I suppose huge military spending and being blockaded on two sides, and bordering Georgia and Iran on the other two, isn’t conductive to prosperity.

The Doldrums consist of Georgia and Moldova. Georgia has had good management under Saakashvili (it is now far less corrupt than Russia, or its Caucasian neighbors, and Ease of Business is very good by global standards), and Moldova has had bad management; nonetheless, their differences in GDP per capita are modest. The problem is that their schools produce people who are, largely speaking, functionally innumerate; so no matter how hard Saakashvili wills it, Georgia isn’t becoming a Singapore of the Black Sea any time soon. Sustained convergence to developed country levels is out of sight; radical improvements in human capital will first have to be made, and they can’t happen in the space of a few years; they require decades. The Saved By Oil group include Kazakhstan and Azerbaijan. They are as wealthy as the Slow Middle, but as stupid as the Doldrums. But in a world of high oil prices they should be relatively well off.

Kyrgyzstan is in the Third World. Although its Soviet-era legacy has enabled it to provide universal primary schooling, the quality of the products of that schooling is comparable to India – at the very bottom of the global heap. It may achieve decent growth of perhaps 4% or 5%, but it will be from a very low base.

There are several conclusions to this. First, there are only really three important factors to economic development. First, above all, human capital, i.e. primarily, the quality of education. It makes sense on an intuitive level and there’s a ton of literature in support but the graph above makes it… graphically clear. Second, resource endowments, when highly concentrated per unit of non-resource extraction based GDP – as in Kazakhstan and Azerbaijan, but not quite in Russia – will hugely, and positively, influence the level of GDP (it does play a substantial positive role in Russia but it should be noted that Russia’s oil production per capita is less than Canada’s, and its oil production per unit of GDP is far less than Kazakhstan’s or Azerbaijan’s). Third, political management. Especially incompetent regimes such as the ones in Ukraine will hold it back from achieving the full potential enabled by its human capital; if its monstrously incompetent and repressive of growth, as in Maoist China, the resulting gap between reality and potential can develop to truly vast proportions; consequently, when the most egregious barriers are removed, as during the late 1970′s, growth takes off at truly prodigal rates.

Equally important is the fact that things commonly cited by Thomas Friedman, Davos Man, The Economist, The WSJ, The Financial Times, the respectable experts, etc. etc. as important for economic growth turn out to be largely irrelevant. Ukraine is more democratic than Russia and Kyrgyzstan is more democratic than China, but their growth profiles are much worse regardless. Russia is fairly corrupt – though not nearly to the extent implied by Transparency International’s Corruption Perceptions Index – and so is Hungary, and they both have much poorer Ease of Business indicators, but they are both much better off than cleaner and business-friendly Georgia. Latvia was part of the “clean” Baltics, but that didn’t stop it from tumbling to the bottom of the Near Developed pack in the wake of the global financial crash; is it too much of a coincidence that Estonia, which has a slightly edge in human capital, managed to hang in tight? The three biggest outliers by far in a best fit line on the graph – China, Kazakhstan, and Azerbaijan – are all patently explainable by a Maoist legacy and oil windfalls.

Suffice to say, most of the former socialist bloc – most of the world, in fact, but that’s for another post – is at precisely the economic development levels implied by their levels of human capital. There are exceptions, most especially China, but to a lesser extent also many of the poorer Near Developed countries, where the distortive legacy of central planning has resulted in lower current economic development levels than should otherwise have been the case had markets been allowed to function; nonetheless, they tend to compensate with respectable growth rates, as the reality – potential gap seeks closure. If you need to blame someone for why your country is poor, don’t bother trotting out the usual canards: State interference, authoritarianism, corruption, anti-Western policies, privatization and liberalization will solve everything! (liberal canards); neocolonialist exploitation (leftist canards); Russian exploitation (East European nationalist canards). More likely than not your countrymen are illiterate, innumerate slobbering buffoons and it’s as simple as that.

* Human capital was calculated by the average of PISA 2000 scores in Math and Science, and of TIMMS 2008 scores in Math and Science. Where data sets for both assessments existed for a particular country, the TIMMS score was – on average – around 7.7% higher than the PISA score, so I adjusted the former down by that amount. The human capital index was calculated by taking the average of the PISA and adjusted TIMMS scores where applicable, or either the PISA score or the adjusted TIMMS score where data for only one of them existed.

(Republished from Sublime Oblivion by permission of author or representative)
 
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There’s been lots of fanfare over China’s GDP overtaking Japan’s in Q2 2010 (coming hard on the heels of a big ruckus over its DF-21 “carrier killing” ballistic missile and rising tensions with the US over North Korea and the South China Sea). The big debate is now whether China will overtake the US as the world’s biggest economy by the 2030′s (as originally argued by Goldman Sachs in their classic Dreaming with BRICs paper), or whether its nomenklatura authoritarianism, centrifugal tendencies and demographic problems will preclude it from ever challenging Pax Americana. My view is that China is underestimated even by many of its proponents: underlying tendencies in world economics and energetics indicate that China’s GDP will overtake America’s before 2020, enabling it to emerge as the last superpower by the 2020′s.

First, there is a major delusion that affects a disturbing amount of the commentary surrounding the size of the American and Chinese economies. Newsflash: nominal GDP and real GDP are different things! China overtook Japan in nominal GDP this quarter, but its real level of output has been the world’s second largest for almost a decade*. The reason China’s nominal, or market exchange rate, GDP is twice lower than its real GDP is because its currency is undervalued relative to the US dollar – simply put, living in China is a lot cheaper than in America. But it’s not an accurate proxy for the actual output of the Chinese economy, which is now at around 2/3 of the US level (IMF)**. The “purchasing power parity” GDP is better suited for gauging a country’s real living standards and economic strength.

Furthermore, many analysts are making the stunningly incompetent, sub-Econ 101 mistake of projecting Chinese’s 10% real growth rates to its nominal GDP. (Needless to say, this is totally absurd; China’s nominal GDP is growing much faster than its real GDP, because as it gets richer its price levels begin to approach those of the developed world). The convenient result of such calculations is to delay China’s sorpasso of the US economy decades into the far future.

Applying linear projections of 10% growth for Chinese GDP and 3% growth for US GDP sees the Middle Kingdom overtaking its superpower rival by 2017. By 2025, China’s economy is 75% bigger than the US.

china-usa-gdp-1

Now one may make the entirely valid observation that linear extrapolation of current trends is bad futurism. I agree. China’s GDP growth will like moderate in the years ahead, as China develops and gets less bang for each investment yuan. On the other hand, there is still plenty of scope for rapid catch-up. China today is where South Korea was in late 1980′s and its trend rate of growth is slightly higher at 10% relative to Korea’s 8% from the 1960′s to the 1980′s. As China gets richer, this growth rate can be expected to ease to 7-8% (Korea in the 1990′s) and 4-5% (Korea in the 2000′s).

The US cannot expect to see anything approaching 3% growth in the next decade. The realistic scenario is 1) a private sector deleveraging as households begin to rein back the debt-income ratios to some semblance of normality and 2) massive yearly budget deficits supporting a permanently weak economy at a 0-1% growth level. Think an American version of Japan’s Lost Decade.

In the graph below, China grows at 10% until 2015, 7% until 2020, and 5% thereafter – roughly replicating South Korea’s trajectory from 1985/1990. The US slugs along at 1% until 2020, then improves to 2%. In this scenario, China sails past the US in 2015 and is 60% larger by 2025.

china-usa-gdp-2

In reality, the world is far more complex than macroeconomics alone can describe. As I argued in Shifting Winds, American hegemony is metastable: though outwardly imposing, an interlinked failure in critical nodes such as energy (e.g. oil shock), finance (e.g. currency flight) and geopolitics (e.g. Iran) can lead to a cascading collapse of the entire system. Few will risk sticking their neck out with such predictions beforehand, but once the collapse becomes visible in our rear-view mirror, it will acquire the tinge of historical inevitability.

The American service-based economy is reliant on cheap and reliable petroleum supplies to keep the office plankton fed and mobile, but is put at critical risk by the imminent peaking of global oil supplies. The financial / credit system relies on trust and belief (“credo”) in future growth to keep functioning as an economic fertilizer, but it is threatened by awning US economic disbalances and the possibility of disruptions in energy supplies. Finally, both the energy and the financial crisis can be triggered by a single geopolitical event, such as a successful Iranian blockade of the Straits of Hormuz (e.g. in retaliation for an Israeli strike against its nuclear facilities).

The risk of cascaded collapse would not exist if Pax Americana faced fewer challenges, or if its foundations were still strong and wholesome. They are most definitely not in our era of permanent deficits, tight oil supplies and imperial overstretch. In the worst case scenario, this collapse could manifest itself in a fall in GDP of up to 30% to a new “steady state” output level.

But at least the US will recover quickly, right? Not likely. Though a US dollar collapse will restore competitivity to some of its older industries, global resource constraints will prevent it from ever fully recovering. Why should increasingly scarce energy sources continue feeding the office plankton of American suburbia, as opposed to Chinese factory cities whose products the entire world wants?

Contrary to popular commentary, China is unlikely to be hurt much by an economic collapse in its prime market. Net exports only account for 7% of China’s GDP, so though exports will decline, so will the imports used to assemble exports, and the overall effect will be modest. Though ebbing US demand for Chinese goods will hurt coastal regions, create unemployment and incite low-level protests, it is unlikely to reach a critical level since China can refocus development efforts on the interior and raising domestic consumption (there are numerous signs that this is already happening).

China’s biggest challenge will be the peaking of its coal production and AGW-induced declines in crop yields within ten to twenty years. Mitigating these developments will require a great deal of capital and ingenuity, things China is fortunate to have in abundance. Ultimately, with 20% of the world’s population but just 7% of its arable land, the Limits to Growth may cap China’s peak GDP at not much more than America’s current level.

On to our third scenario. From 2011, some combination of critical system shocks initiates a cascading collapse of Pax Americana, resulting in a cumulative US GDP decline of 30% from peak (this is similar to Latvia’s collapse in 2007-2009). After that, there is a permanent zastoi – unlike in previous emerging market crises, a significant recovery will be impossible in the new world of neo-mercantilism and energy constraints. China will be able to leap past the US sometime around 2013-15 and grow to more than double its size by 2025 – despite the slowing of China’s own growth due to peak exergy and the natural effects of economic catch-up.

china-usa-gdp-3

What is the probability of each of these scenarios happening? In my opinion, Scenario 1 is pure fantasy. Scenario 2 is what I’d vouch for in “respectable” conversation. Scenario 3 is what I really believe will happen (and what I tend to write about on this blog).

In any case, the general outline is clear: no matter which “prism” you see the world through – be it techno-cornucopian, “realist”, or peakist – it appears that China, by sheer virtue of combining 1.3bn souls with modern technics, is destined to soar past the US to become the leading pole, if not of the world system, then certainly of the Pacific region.

This breakout will be all the more dramatic under the American collapse scenario: wracked by internal decline and preoccupied with internecine politicking, it’s not impossible to imagine the US simply not noticing the ebbing of its influence in East Asia. Of course, there’s a perfect precedent for this: see how post-Maoist China managed to break past the seemingly impregnable Soviet empire that collapsed into anarchic stasis in the early 1990′s.

russia-china-gdp

[Angus Maddison's data adjusted to equalize with IMF 2008 data; note that "former USSR" is a very rough estimate].

* There’s a big debate on the reliability of official Chinese economic statistics. Are Chinese statistics manipulated? by Gao Xu is a recommended rebuttal h/t “in the loop”.

** That is also assuming that the 30% downwards revision to Chinese GDP by the World Bank and IMF a few years ago was well-founded and not undertaken out of political considerations to preserve America’s #1 status. If not, China’s real GDP may already be surging past America’s.

(Republished from Sublime Oblivion by permission of author or representative)
 
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Anatoly Karlin
About Anatoly Karlin

I am a blogger, thinker, and businessman in the SF Bay Area. I’m originally from Russia, spent many years in Britain, and studied at U.C. Berkeley.

One of my tenets is that ideologies tend to suck. As such, I hesitate about attaching labels to myself. That said, if it’s really necessary, I suppose “liberal-conservative neoreactionary” would be close enough.

Though I consider myself part of the Orthodox Church, my philosophy and spiritual views are more influenced by digital physics, Gnosticism, and Russian cosmism than anything specifically Judeo-Christian.